Of bank loans, wagyu beef and ‘the finest shiraz’

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Must loan approval assessments be based on an individual borrower’s declared expenses?

Richard Massey

In a landmark judgment last week, the Australian Federal Court answered that question with a resounding “no”.

In part, that was because a borrower’s declared expenses are not necessarily reflective of affordability.

In the colourful phrasing of Justice Nye Perram: “I may eat wagyu beef every day, washed down with the finest shiraz, but if I really want my new home I can make do on much more modest fare.”

The judgment limits the scope of responsible lending legislation, and may be welcome relief for lenders in a climate of intense regulatory scrutiny.

While the judgment turned on the particular statutory test under Australian law, it is likely to be influential when similar issues are tested before the New Zealand courts.

The factsThe Australian Securities and Investments Commission (ASIC) claimed Westpac had breached the National Consumer Credit Protection Act 2009 (NCCPA) in relation to loans approved from 2011 to 2015 because of its use of automated loan approval systems.

Those systems relied in part on the Household Expenditure Measure (HEM) – an algorithmic benchmark developed by various banks, including Westpac, to measure hardship based on demographic spending habits.

Make reasonable inquiries about the consumer’s requirements, objectives, and financial situation;

Decline the application if it is likely the consumer will be unable to comply with his/her obligations under the loan (or could comply only with “substantial hardship”);

Decline the loan if it would not meet the consumer’s requirements or objectives.

Similar tests apply under New Zealand’s responsible lending framework.

ASIC claimed Westpac was required to have regard to the actual living expenses declared by borrowers in their application forms, but failed to do so. It accepted Westpac could use the HEM benchmark in part, but argued the assessment should be based on the results of its inquiries of borrowers.

The judgmentJustice Perram rejected ASIC’s arguments and dismissed its claim.

First, he disagreed that Westpac had failed to have regard to living expenses. This was because part of the automated process involved assessing whether the expense information, as submitted by borrowers, exceeded 70% of their monthly income.

Second, he held that while the NCCPA required lenders to inquire into borrowers’ financial situations, and whether they were likely to comply with obligations without hardship, that did not mean they must use declared living expenses in doing so.

The judge noted the NCCPA was silent on how lenders were to assess likely affordability, and said not all the information gathered through inquiries would be relevant.

Fundamental to the judge’s reasoning was that “it is always possible that some of the living expenses might be foregone by the consumer in order to meet the repayments”.

For example, gym expenses may be excluded on an application form, but could be dropped within the first week of the loan. Likewise, the judge said if a borrower spent “$100 per month on caviar”, that would throw no light on affordability for NCCPA purposes.

The upshot is that a customer’s recorded expenses might exceed their stated income but a lender could still reasonably decide that the loan is suitable and affordable.

In other words, as the judge put it: “with knowledge of the consumer’s declared living expenses, one may well be able to discern that a consumer will have to trim their sails if the loan proceeds. But there is arguably a conceptual gulf between a trimming of sails and poverty.”

He acknowledged that where expenses were demonstrably minimal in nature, and could not be forgone, these would be “necessarily relevant” to the affordability assessment. But this would require additional information to show those were the minimum possible expense.

As ASIC had not adduced any such additional information in evidence, the judge ruled Westpac had not breached its obligations.

More generally, the judge said: “A credit provider may do what it wants in the assessment process, so far as I can see; what it cannot do is make unsuitable loans.” He even described as “contestable” the general submission by ASIC that responsible lending obligations involved “new norms of conduct” and should be construed liberally.

ASIC has 28 days to lodge an appeal and says it is “reviewing the judgment carefully”.

The result will be particularly welcome to Westpac because it had provisionally agreed to settle the claim for A$35 million in 2018 but the court refused to grant the settlement orders sought.

It said the parties had failed to articulate the agreed breaches and it would not “rubber stamp” settlements where there was “patent disagreement as to what conduct constitutes a contravention”.

New Zealand’s positionNew Zealand also has a “responsible lending” regime, although the analogous part of the test is worded somewhat differently in section 9C of the Credit Contracts and Consumer Finance Act 2003 (CCCFA).

As in the Australian regime, the purpose of the lender’s reasonable inquiries is to assess suitability and affordability. And, as with the NCCPA, the CCCFA does not prescribe how lenders are to make reasonable inquiries or how the requisite satisfaction about affordability and suitability must be reached.

Similarly, while MBIE’s guidance in the Responsible Lending Code sets out various non-binding recommendations, (including that lenders should consider borrowers’ expenses), it does not prescribe what information should determine the outcome of the assessment.

In that respect, Justice Perram’s approach in ASIC v Westpac is apt: “to say that information is collected for a purpose says nothing expressly about how that purpose is to be achieved.”

Given the similarities between the Australian and New Zealand regimes, the Westpac decision is likely to be influential in New Zealand.

If the New Zealand courts adopt a similar approach, our lenders would be entitled to consider a broader range of information in satisfying themselves about the suitability or affordability of a loan for an applicant borrower.

One of the proposed changes is the introduction of new regulation-making powers, allowing for more prescriptive rules specifying the particular inquiries that must be made to satisfy section 9C of the CCCFA.

If adopted, that approach would likely be a departure from the more flexible approach adopted by the court in ASIC v Westpac. It remains to be seen whether the Australian court’s reasoning will prompt a reconsideration of the proposed legislation on this side of the Tasman.